How To Use Equity As A Deposit In Australia

A homeowner can use equity as a deposit by borrowing against the usable portion of an existing property’s value.

The released funds may cover a deposit and purchase costs for another home or investment property.

This does not remove the need for borrowing. The equity release increases the debt secured against the first property while the buyer also finances the next purchase.

The amount available depends on the lender valuation, the existing mortgage balance and the lender’s loan-to-value limit.

A lender must also be satisfied that the borrower can service the combined debt.

What Is Home Equity?

Home equity is the difference between the current market value of your property and the outstanding balance on your mortgage. It represents the portion of your home that you truly own.

For example, if your property is worth $800,000 and your remaining mortgage balance is $500,000, your equity is $300,000.

Not all equity is immediately accessible. Lenders typically allow you to use up to 80% of your property’s value, minus the existing loan amount. This is known as usable equity. In the example above, the usable equity would be $140,000 (80% of $800,000 is $640,000, minus the $500,000 mortgage).

How Does Home Equity Grow?

Home equity grows in two main ways: through property value appreciation and mortgage repayments. As property prices increase over time, the market value of your home rises, which directly boosts your equity.

Similarly, as you make regular mortgage repayments, the outstanding loan balance decreases, further increasing your equity.

For instance, if you purchased a property for $600,000 with a $480,000 mortgage and its value later rises to $700,000, the equity is the new value minus the loan balance at that time. A fresh lender valuation is needed before treating any increase as usable equity.

How Equity Release Works

Equity release refers to the process of accessing the equity in your home to secure additional financing. This can be done through specific financial products designed to unlock the value tied up in your property.

Types of Equity Loans

There are two main types of equity loans:

1. Home Equity Loans: These provide a lump sum secured against the property and can suit a known deposit amount or one-time expense.

2. Lines of Credit: These offer flexible access to funds up to a pre-approved limit. You can draw on the funds as needed, making them suitable for ongoing or variable financial needs.

Loan-to-Value Ratio (LVR)

The Loan-to-Value Ratio (LVR) is the percentage of a property’s value financed through loans. A $560,000 debt against a $700,000 valuation has an LVR of 80%.

To avoid Lender’s Mortgage Insurance (LMI), lenders generally require an LVR of 80% or less. This means you can only access equity up to this limit, ensuring a buffer remains in your property’s value.

How to Qualify for Equity Release

To qualify for equity release, lenders assess income and living expenses as well as existing repayments and credit history.

The lender uses these checks to assess whether the combined repayments meet its serviceability rules. The additional debt still needs to fit within those rules.

Strategies For Using Equity As A Deposit

Equity Calculation

To determine your usable equity:

1. Obtain a Property Valuation: Engage a professional to assess your property’s current market value.

2. Calculate Total Equity: Subtract your outstanding mortgage balance from the property’s value.

3. Determine Usable Equity: Apply the 80% LVR cap and subtract the existing loan amount.

For instance, if your property is valued at $700,000 and your mortgage balance is $400,000, your total equity is $300,000.

Usable equity would be $160,000 (80% of $700,000 is $560,000, minus $400,000).

Step-By-Step Process

1. Compare lender policies: Check which lenders will accept the proposed purpose, security structure and borrower circumstances.

2. Prepare the application evidence: Collect income, expense, liability and property documents for the lender’s assessment.

3. Approach Lenders: Compare the available equity-release structure, serviceability result, rate and fees.

4. Understand Loan Terms: Review repayments, offsets, redraw conditions and the security attached to each loan.

Benefits and Risks

Benefits:

• Usable equity may cover a deposit when the owner does not want to wait until the same amount is saved in cash.

• A separate equity split may leave existing cash available for purchase costs or a reserve, subject to approval.

Risks:

• A lower lender valuation may leave too little usable equity for the planned deposit.

• Enough equity does not guarantee approval when the borrower cannot service the proposed loans.

• Using most of the available equity can leave less room for purchase costs and unexpected expenses.

Financial Products Using Home Equity

Choose a fixed advance when the required amount is known. Reusable access may fit staged spending, but it needs tighter control because the borrower can draw funds again.

Types of Financial Products

1. Home Equity Loans: A fixed advance fits a deposit or project with a known amount and gives the borrower a defined balance to repay.

2. Lines of Credit: Reusable credit fits costs paid in stages or amounts that are not known at the start. Interest applies to funds drawn, and later withdrawals can increase the debt again.

Common Uses

• Investment in Additional Properties: Equity can fund the deposit for another property, but it increases debt secured against the existing property.

• Financing Renovations: Equity can fund home improvements, potentially increasing your property’s value.

• Covering Large Expenses: Equity can also fund education, medical bills or other large costs, although the borrower may repay that spending over a long mortgage term.

Refinancing Options

Refinancing replaces the existing mortgage with a new loan at a higher balance, releasing the difference for the approved purpose. Compare the new rate, fees, loan term and property security with the cost of adding a separate equity facility.

Advantages And Risks Of Equity Financing

The equity release raises the repayments on the existing property. It can also increase the LVR and place that property at risk if the secured debt is not repaid.

Advantages

• Provides access to larger sums of money compared to unsecured loans.

• Often comes with lower interest rates than personal loans or credit cards.

• Helps avoid LMI if the deposit percentage meets lender requirements.

Risks

• Increased Debt Load: Higher loan amounts mean larger monthly repayments, which can strain your finances.

• Risk of Foreclosure: If you cannot meet repayment obligations, you risk losing your property.

• Market Fluctuations: Declines in property value can reduce your equity, impacting your financial stability.

Mitigating Risks

Keep accessible cash for higher repayments and unexpected property costs. Test the combined loans against a lower valuation or a period without rent before borrowing near the limit.

Legal And Financial Considerations

Review which property secures the new borrowing, the repayment obligations and any conditions that affect a later sale or refinance. The agreement should show whether the lender can rely on one property or both properties if repayments are missed.

Reviewing Equity Loan Agreements

• Check the security and repayment terms: Confirm the loan amount, interest basis, repayment schedule and every property listed as security.

• Review before acceptance: Ask a solicitor to explain guarantees, default clauses and restrictions that could affect a later sale or refinance before signing.

Financial Planning Suggestions

• Maintain a Financial Buffer: Keep a reserve of funds beyond the used equity to cover unexpected expenses.

• Regularly Review Property Values: Monitor your equity status to identify opportunities for refinancing or further investments.

• Plan for Repayment: Develop a clear strategy for managing increased debt and meeting repayment obligations.

Tax Implications

Using equity for investment purposes may have tax implications. For example, interest on loans used to purchase investment properties may be tax-deductible.

Consult a tax advisor to understand how equity financing affects your tax obligations.

Conclusion

Using equity as a deposit can let a homeowner buy sooner, but the released amount becomes additional debt. Confirm the lender valuation, calculate usable equity and test the combined repayments before comparing a separate loan split with refinancing.